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With Leverage Ratios Firmed Up, Attention Turns To RWA Density

Much heavy lifting has already been done to raise European banks' capital ratios, as a new analysis by S&P Global Market Intelligence shows —data drawn from 30 European banks, both eurozone and non-eurozone, shows that these institutions reported at the end of 2015 fully loaded common equity Tier 1 ratios of at least 10% and most announced leverage ratios of 4.0% or higher.

But there is more work to do as regulatory attention begins moving to the risk-weighting of assets.

Unlike with common equity Tier 1 ratio targets, however, the expectations around risk-weight assets density (fully loaded RWA divided by total assets) and the changing risk assessment under what is increasingly referred to as Basel IV, the road ahead is not entirely clear, with various parts still under consultation. Nonetheless, the recalibration of standardized risk models and the introduction of minimum risk-weighting floors look certain.

"RWA density will rise," Shailesh Raikundlia, a bank analyst at Haitong, said.
"RWA density will rise," Shailesh Raikundlia, a bank analyst at Haitong, said. Yet he pointed out that the changes will be introduced in 2018 for 2019 and that many banks are creating "management buffers" of capital to cover the eventualities.

In the U.K., the large banks have already made preparations for the revised asset risk assessment by creating capital buffers under Pillar 2A. Raikundlia explained that the capital demanded and injected here has been quietly raised to cope with the expectation that risk-weighted assets will rise under revised asset risk assessment. (He also thought this was almost certainly done under regulatory pressure.)

Big balance sheet moves are possible. In setting out its strategy in October 2015, Deutsche Bank, for example, saw itself cutting its RWAs by €120 billion by 2020 but incurring €100 billion in regulatory inflation during the same period.

Raikundlia said it is vital to look at the risks in the underlying bank portfolios, something, however, that is neither simple nor transparent unlike the leverage ratio.

Looking to Sweden

FY 15 Fully Loaded CET1 Rations and RWA Densities For Select European Banks

Indications of the way risk-weighting could move come from Sweden. Finansinspektionen, the Swedish regulator, proposed March 1 that the national rules for corporate risk weighting be tightened by assuming more frequent and higher defaults, and Finansinspektionen has been similarly tough on mortgage lending. At the end of 2015, Sweden's largest banks held Pillar 2 capital buffers to reflect a 25% risk weight floor on Swedish mortgages. Troiano viewed these moves positively as they protect the system from unwanted capital releases.

S&P Global Market Intelligence's data combining banks' fully loaded CET1 ratios and RWA density indicates that there is an inverse relationship between the former and the latter.
 It would be hard for other European banks to follow suit. A 25% mortgage floor would have a significant effect on the capital ratios of Lloyds Bank where, Raikundlia observed, around two-thirds of the loan book consists of mortgages currently risk-weighted at 10%.

Target practice

Not everyone is impressed with the recapitalization that has taken place. Academic observers and economists, among others, think banks' leverage remains too low and that too much risk can still be carried off-balance sheet.

Johan De Mulder, a bank analyst at Bernstein, wrote Jan. 7 that the regulatory move toward risk-weighting harmonization was "essentially a bottom-up attempt to raise capital for banks that do not come close to the 5% tangible leverage requirement already met by almost all banks in the U.K. and U.S." He said that high CET1 ratios gave "a false sense of security." Many of these ratios, as the figures in our analysis, show, are based on just 20% of total assets.

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 S&P Global Market Intelligence's data combining banks' fully loaded CET1 ratios and RWA density indicates that there is an inverse relationship between the former and the latter. In other words, the higher (or lower) the asset density, the lower (or higher) the CET1 ratio. However, the relationship is not linear and depends on the banking model used.

FY 15 Leverage Ratios and RWA Densities For Select European Banks

Deutsche Bank, Société Générale SA and BNP Paribas SA show relatively low capital relative to their asset density, reflecting their universal bank models and, in particular, their large trading books. By contrast, Banco Bilbao Vizcaya Argentaria SA, Standard Chartered Plc and HSBC have high asset density relative to capital, reflecting their generally traditional banking models.

Nov 14, 2016